National Market System (NMS)

What it is:

The national market system (NMS) is a system that regulates the disclosure and execution of trades across all exchanges.

How it works (Example):

Congress established the National Market System in 1975. The NASD and Nasdaq sponsor the NMS. Basically, the NMS requires all exchanges to provide everyone with the same access to quotes. This theoretically puts individual investor on par with institutional investors.

Specifically, the NMS requires exchanges to display stock prices in increments no smaller than a penny. It also has a trade-through rule, which means that a buy order entered at the Nasdaq could be executed on the NYSE if the a seller there is offering the stock at a lower price.

Some critics of the NMS argue that the trade-through rule slows down trades, and that this can harm investors who value speed of transaction over price. Additionally, the quotation system typically shows the best price at which a security is offered, but it is harder to see all the prices at which a security is offered at a given point in time. In some cases, this may mean that a buyer, for example, might spend more buying separate blocks of shares at prices that, when averaged, are higher than what the buyer might have spent buying one block of shares.

The NMS also requires exchanges to make bids and offers visible to all buyers and sellers, which makes it harder for institutions and other investors to execute large trades discreetly. In turn, the critics argue, the NMS has fueled the expansion of dark pools, which are essentially private exchanges.

Why it Matters:

The NMS helps investors obtain the best price possible for securities by simultaneously posting the prices for securities trading on the major and regional exchanges. This supports the goals of free market competition and confidence in the public markets via transparency and best execution. The system is not without flaws, however.

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